The first 20% of an oil well's production gushes out, thanks to natural pressure. That eventually drops, and you can push out another 20% by flooding the well with water. When that's finished, you can do carbon-dioxide flooding, a highly effective technique that is Denbury's specialty. Carbon dioxide is an unusual gas. It loves oil. Denbury (ticker: DNR) injects highly pressurized CO2 into a well. It finds the oil, bonds to it, and pushes it out.

This quarter, the Plano, Texas-based company will pay its first-ever dividend, of 25 cents. Next year, that dividend will grow to between 50 cents and 60 cents a share, giving the stock a yield of about 3%. At a recent $16.46 a share, the stock trades at 4.5 times free cash flow, well below the industry average of 6.8. Closing the gap could push the shares up at least 20%, to $20, not including the dividend.

CO2 injections are a big reason that the Permian Basin, first developed in the 1920s, is still producing oil. To fans, the technique is ingenious, capturing greenhouse gases from polluters and stowing it underground. Says Steve Melzer, a consulting geological engineer in Midland, Texas: "It uses and stores [something] considered to be a growing issue in the atmosphere and accomplishes this in very large quantities."

Not everyone can do it. For one thing, CO2 isn't cheap: It accounts for more than a quarter of the $25 it costs Denbury to extract a barrel of oil. Over the past seven years, Denbury has spent $2 billion to build plants to retrieve CO2 and some 1,100 miles of pipeline to carry it. It now has a 9.6 trillion cubic feet of CO2, including a huge deposit in an extinct, Cretaceous-era volcano in Mississippi.

Denbury has bought and sold assets worth $4 billion over the past two years to become more of a pure play on CO2 flooding. It now has 1.2 billion barrels of potential reserves, a decade's worth of inventory. About half of its production is conventional now, but is slated for CO2 flooding as the fields age.

All of this is good news for investors, who cooled their heels last year after company chief Phil Rykhoek decided against turning the company into a master limited partnership, dashing hopes for a yield of 8% to 9% sported by MLP rivals. Rykhoek reasoned the CO2 assets were crucial to Denbury and dividing them out would raise conflicts of interest. Instead, the company would stick with its conservative strategy, altering its development plan, pushing some planned CO2 floods a year or two out, and refocus on cash flow.

In November, Rykhoek said production growth would slow to between 4% and 8%, from the company's previous target of 5% and 10%. The stock promptly crashed, and ended the year flat. That makes the CEO scratch his head. His mature fields are strong growers, he told Barron's, adding, "Our four biggest [fields] are still in the growth phase, and haven't reached full development yet. Our strategic advantage is that we control different sources of CO2, and we also control the pipeline."

To be sure, CO2 recovery isn't without its problems—periodically, carbon dioxide and drilling fluids can break out of old wells, especially if they're improperly capped: Last year, toxic fluids poured from an abandoned well that Denbury purchased from another operator. Denbury set aside $200 million to address the issue, and it also re-examined its wells.

AFTER YEARS OF INVESTMENT, Denbury's capital-spending cycle moderates this year, falling from $1.6 billion in 2012 to an annual $1 billion or so for the next several years. As a result, cash flow from operations is expected to jump from an estimated $1.3 billion this year to $1.5 billion in 2015, says Chip Carlson, who runs the Greenspring fund. Subtract the $1 billion in capital spending and that leaves half a billion that could easily allow Denbury to boost the 2016 dividend to 75 cents a share.

The Bottom Line

Denbury's focus on free cash flow will pay off in stock buybacks and a sharply rising dividend. Shares, which trade at a discount, could rise 20%.

Denbury is cheap relative to its mid-cap peers, trading at a 36% discount to net asset value—that is, the present value of its assets adjusted for debt. According to JPMorgan Chase, peers trade at an average discount of 20%. Management says it will buy back shares so long as they trade below NAV.

Production companies "will spend money to get a certain production rate to hit their annual target," Rykhoek says. "That's not a good rate of return on investment." Fortunately, Denbury shareholders can expect something different.